Sunday, January 27, 2019

Charlie Munger on learning to be a great investor

A frequently asked question is, how do you learn to be a great investor? 
First of all, you have to understand your own nature, said Munger. "Each person has to play the game given his own marginal utility considerations and in a way that takes into account his own psychology. If losses are going to make you miserable—and some losses are inevitable—you might be wise to utilize a very conservative pattern of investment and saving all your life. So you have to adapt your strategy to your own nature and your own talents. I don't think there's a one-size-fits-all investment strategy that I can give you."   
Then, says Munger, you have to gather information. "I think both Warren and I learn more from the great business magazines than we do anywhere else," said Charlie. "It's such an easy, shorthand way of getting a vast variety of business experience just to riffle through issue after issue covering a great variety of businesses. And if you get into the mental habit of relating what you're reading to the basic structure of the underlying ideas being demonstrated, you gradually accumulate some wisdom about investing. I don't think you can get to be a really good investor over a broad range without doing a massive amount of reading. I don't think any one book will do it for you." 
...Munger explained that a person's reading should not be random: " have to have some idea of why you're looking for the information. Don't read annual reports the way Francis Bacon said you do science—which, by the way, is not the way you do science—where you just collect endless data and then only later do you try to make sense of it. You have to start with some ideas about reality. And then you have to look to see whether what you're seeing fits in with proven basic concepts. 
"Frequently, you'll look at a business having fabulous results. And the question is, How long can this continue?' Well, there's only one way I know to answer that. And that's to think about why the results are occurring now—and then to figure out the forces that could cause those results to stop occurring."  
This is the method of thinking that helps Munger and Buffett spot a company that has a franchise on a certain product, a so-called "moat" around its business. There are several examples of companies that have such a strong name brand that they seem invincible. Coca Cola has been such a company, though the challenges are relentless. Munger also uses the example of Wrigley's Chewing Gum.  
"It's such a huge advantage to be by far the best-known gum company in the world. Just think of how hard it would be to replace that image. If you know you like Wrigley's Gum and you see it there for two bits, are you really going to reach for Glotz's Gum because it's 20 cents and put something you don't know in your mouth? It's not worth it for you to think about buying an alternative gum. So it's easy to understand why Wrigley's Gum has such a huge advantage."  
Once you grasp the value of a company, then you have to decide how much the company is worth if you were buying it outright, or as in the case of the typical investor, simply buying a portion of the company on the stock market.  
"The trouble with the Wrigley Gum-type investments is that everybody can see that they're wonderful businesses. So you look at it and you think, My God! The thing's at eight times book value or something. And everything else is at three times book value.' So you think, 'I know it's wonderful, but is it wonderful enough to justify that big a premium?'"  
The ability to answer such questions explains why some people are successful investors and others are not.  
"On the other hand, if it weren't a little difficult, everybody would be rich," Munger insisted.